HYPOTHECATION OF MOVABLE MACHINERY, LETTER OF CREDIT &

PACKING CREDIT

What constitutes Movable Machinery?

All stores and spare parts
Both present and future

Belonging to the borrower

Being and lying in the borrowers premises or godowns of or rented by the borrower or otherwise used in connection with the business of the borrower

Salient Features of hypothecation of movable machinery

Hypothecation is one of the most popular methods of creation of charge on movable assets without transferring possession of the assets The property is charged with the amount of a debt but neither ownership nor possession is passed to the creditor Security remains in possession and control of the borrower and is charged in favour of the bank through documents executed by the borrower

Salient Features of hypothecation of movable machinery

The documents contain a clause that obligates the borrower to give possession and control of movable machinery on demand. Once possession is given to the bank, it is akin to a pledge There is no transfer of interest in the property but represents an obligation to repay the debt. It evidences an equitable right

Salient Features of hypothecation of movable machinery

Since the securities are with borrowers, he/she can, in the normal course of business, sell the same and can purchase further movable machinery If a need arises the bank may seize the movable machinery without intervention of the court, sell the same and appropriate the proceeds towards the dues including Interest + Expenses All hypothecation letters should be stamped as per the Stamp Act

Letter of Confirmation
Place, Date, Stamp, Name Declaration regarding Movability of Machinery

Obtained from the Borrower

Advance Account Details, Declaration Small tin plate with wordings Hypothecated to ..Bank ....Branch should be fixed on each machinery to evidence that the Plant & Machinery are under hypothecation to the Bank

Instrument of Hypothecation of Movable Machinery

Clause 1:Balance due to the Bank Principal, interest, charges and expenses Clause 2:Hypothecated machinery Clause 3:End use of funds

Clause 4:Payable on demand

Clause 5:Interest rate

Instrument of Hypothecation of Movable Machinery

Clause 7: Borrower agrees & undertakes : Not to sell the hypothecated machinery, nor give it to anyone without prior consent of the bank Not to open advance a/c with any other bank without prior consent of bank Clause 8: Maintenance
Clause 9: Inspection Clause 10:Board or boards with the name of bank legibly and distinctly printed or written to be placed at all times at all the hypothecated premises

Instrument of Hypothecation of Movable Machinery

Clause 15:Remove or Dismantle Borrower is prohibited from removing or dismantling any moveable machinery in use without the consent in writing from the bank Clause 17:Hypothecated machinery will be at all time the absolute property of borrower. Clause 18:If borrower fails to perform any obligation or in case of any damage to hypothecated machinery Bank can obtain possession At borrower risk & expense Possession and control shall be apparent and indisputable The hypothecated machinery can also be sold by the bank

Instrument of Hypothecation of Movable Machinery

Clause 20:After 48 hrs notice from possession of the hypothecated machinery without assigning any reason Bank can sell either by public auction or private contract Borrower undertakes to transfer all relative contracts, securities, bazaar chits, bills, notes, hundies and documents to bank Borrower is bound by banks decision. Clause 22:Pay, rents, rates, taxes Clause 28:Default in repayment

Difference between Hypothecation of goods and merchandise

Hypothecation of Movable machinery Hypothecated machinery can not be sold or given on rent Hypothecation of merchandise Securities are with borrowers, he/she can, in the normal course of business, sell the same and can purchase further goods Usually the credit facility would be for Cash Credit (Working capital requirement)

Usually the credit facility would be Term loan

Valuation traditionally on WDV / historical value

Value changes in accordance to depreciation

Valuation Market Value or Cost (whichever is less) net of creditors if any

If goods not sold for a long period, might become obsolete or lose value.

Letter of Credit

Definition and Purpose

A Letter of Credit, simply defined, is a written instrument issued by a bank at the request of its customer, the Importer (Buyer), whereby the bank promises to pay the Exporter (Beneficiary) for goods or services, provided that the Exporter presents all documents called for, exactly as stipulated in the Letter of Credit, and meet all other terms and conditions set out in the Letter of Credit. A Letter of Credit is also commonly referred to as a Documentary Credit Letters of credit are especially useful if you're not wellestablished, you don't have the best credit, you're dealing with an overseas company and you want to give assurance that you'll pay for your products

Parties involved
Applicant The applicant is normally the buyer of the goods . i.e. the importer who request his bank to issue a letter of credit in favour of a named beneficiary against tendering of certain specified documents Beneficiary The beneficiary is normally the seller of goods who receives payment under documentary credit if he has complied with terms and conditions thereof .

Parties involved(cont.)
Issuing Bank The issuing bank or the opening bank is one which issue the credit , i.e. undertake , independent of the Undertaking of the applicant , to make payment provided the terms and conditions of the credit have been complied with Advising Bank The advising bank advises the credit to the beneficiary thereby authenticating the genuineness of the credit Confirming Bank A confirming bank is the one which adds its guarantee to the credit . It undertakes the responsibility of payments / negotiation / acceptance under the credit in addition to that of the issuing bank

Parties involved(cont.)
Nominating Bank A Nominating bank is the bank nominated or authorized by issuing bank to pay , to incur a deferred payment liability , to accept drafts or to negotiate the credit Reimbursing Bank A reimbursing bank is the bank authorized to honour the reimbursement claims in settlement of negotiation with the paying or accepting bank

Characteristics

Negotiability Revocability Transfer and Assignment Sight and Time Drafts

Standard forms of Documentation

Commercial Invoice Packing List Bill of lading and other transport documents Certificate of Origin Inspection Certificate Bill of Exchange Insurance Documents Warranty of title

Common Defects in Documentation

Letter of credit has expired prior to presentation of draft Bill of lading evidences delivery prior to or after the date range stated in the credit Stale dated documents Inconsistent description of goods Insurance document errors Invoice amount not equal to draft amount Ports of loading and destination not as specified in the credit Document required by the credit is not presented

Functions
1. Payment Instrument In absence of letter of credit, sight or time drafts used 2. Performance Guarantee Payment by bank would not be released until goods and document conforms to specifications on letter of credit 3. Financial Instrument Seller can use letter of credit as collateral to finance production and exportation of good

Advantages
EXPORTER IMPORTER

Credit risk eliminated Expert Examination of Reduces exchange rate and Documents political risk Sources of Supply expand No Need for Credit Check Financing Pre-shipment risk avoided No cash tied up Facilitates financing Payment only after compliance Immediate payment To ship by a certain date
requires an on-board bill of lading

Disadvantages
EXPORTER IMPORTER

Strict Compliance of
Documentation

No protection to importer
against exporter shipping inferior quality goods and/or a lesser quantity of goods

Lack of credit facility to

importer inhibits growth

Importer Line of Credit

Outstanding Amount Limit

Risks Involved
1. Risk of Beneficiary not shipping goods persists 2. The Letter of Credit as a payment method is costlier than other methods of payment such as Open Account or Collection 3. The Beneficiarys documents must comply with the terms and conditions of the Letter of Credit for Issuing Bank to make the payment 4. The Beneficiary is exposed to the Commercial risk on Issuing Bank, Political risk on the Issuing Banks country and Foreign Exchange Risk in case of Usance Letter of Credits

Case Study
The steps mentioned in the example A business called the InCosmetika from time to time imports goods from a business called ACME, which banks with the ABC Bank. InCosmetika holds an account at the Commonwealth Bank. InCosmetika wants to buy $500,000 worth of merchandise from ACME, what steps should be taken to get a LC ?

Case Study
1. InCosmetika goes to The Commonwealth Bank and requests a $500,000 letter of credit, with ACME as the beneficiary.
2. The Commonwealth Bank can issue a letter of credit either on approval of a standard loan underwriting process or by InCosmetika funding it directly with a deposit of $500,000 plus fees which are typically between 1% and 8% of the face value of the letter of credit. 3. The Commonwealth Bank sends a copy of the letter of credit to the ABC Bank, which notifies ACME that payment is available and they can ship the merchandise InCosmetika has ordered with the full assurance of payment to them. 4. On presentation of the stipulated documents in the letter of credit and compliance with the terms and conditions of the letter of credit, the Commonwealth Bank transfers the $500,000 to the ABC Bank, which then credits the account of ACME for that amount.

Types of Letter of Credit

There are basically 2 types of letters of credit:1.Commercial letter of credit 2.Standby Letter of credit

Standby letter of credit

9

Contract
1

Applicant

Beneficiary

Debit
Letter of Credit Application
7

Payment
6 5

Letter of Credit

Documents

Applicants Bank

Documents
3

Other types of letters of credit

1. 2. 3. 4. 5. 6. 7. 8.
Revocable/Irrevocable Confirmed/Unconfirmed Restricted/Unrestricted Transferable Back-to-back Revolving Deferred Red clause/Green Clause

Confirmed Letter of Credit cycle

5. Product is
Shipped

1.
Beneficiary Exporter/Seller

1.

Buyer & Seller Agree

2.
Application

6.
Documents

Applicant Importer/Buyer

4.
Confirmed Letter of Credit Confirming Bank

8.
Documents

3. Letter of 10.
Exporters Bank/ Advising Bank/ Confirming Bank Credit

2. 7. Documents 9.
Importers Bank/ Issuing Bank

Packing Credit

Packing Credit
Pre-shipment fund based credit facility for a specific period extended by the banks to those customers who have received a confirmed order or LC for export of merchandise, on the terms indicated.

It is provided for working capital needs like: Procure raw materials, carry out manufacturing process. carry out manufacturing process and pack goods Provide a secure warehouse for goods and raw materials. Ship the goods to the buyer.

Pre-shipment finance is extended in the following forms : Packing Credit in Indian Rupee Packing Credit in Foreign Currency (PCFC)

Eligibility for Getting Packing Credit

An exporter should usually hold an export order or letter of credit in his own name to perform an export contract. A ten digit importer exporter (IE) code number allotted by DGFT. Exporter should not be in the caution list of RBI. If the goods to be exported are not under OGL, the exporter should have the required license /quota permit to export the goods.

Running Account Facility

The RBI has permitted banks to grant packing credit advances even without production of L/C or firm order/ contract under this scheme Facility subject to the following conditions L/C or firm order is produced within a reasonable period of time. For commodities under selective credit control, banks should insist on production of L/Cs or firm orders within one month from the date of sanction. Packing credit may also be given under the Red Clause letter of credit

Different Stages of Packing Credit

Appraisal and Sanction of Limits Disbursement of Packing Credit Advance Follow up of Packing Credit Advance Liquidation of Packing Credit Advance Overdue Packing

Documents Required :
DPN Letter of Continuing Security Pledge/hypothecation of goods Undertaking to adjust each PC drawdowns in a time frame by export proceeds

Pre-shipment Credit Foreign Currency

PCFC is available to exporters for domestic and imported inputs of goods to be exported at LIBOR related rates of interest as decided by RBI To qualify for this purpose, the exporters overdue bill should not exceed 5% of the average annual export realization during the preceding three years

Terms & Conditions :

The corporations/exporters having firm export orders or confirmed L/C are eligible for PCFC, provided they satisfy other credit norms of the Bank. PCFC is to be repaid with the proceeds of the export bill submitted after shipment.

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